This blog was written by: Craig Coulson, Senior Trust Officer
Many professional estate administrators emphasize the emotional toll and time-consuming steps that are reduced or eliminated when a corporate executor is named in one’s will. Sometimes, beneficiaries may be unhappy with corporate executor fees, perhaps thinking if only they were appointed, they would save the estate the cost of administration. What is not frequently mentioned is how the appointment of a professional executor may save the estate money in the long run by utilizing their professional expertise with respect to an estate’s biggest expense, tax!
When the testator passes away with a controlling interest in a private corporation, it is vital to engage a tax professional to reduce the potential of double, or even triple taxation arising on the value of the same assets. In my first article on this topic, published on February 23, 2023, I attempted to illustrate the loss carryback strategy. In this article, I will address another strategy commonly known as pipeline planning.
How can the same assets be taxed twice? I will use an example of John, who has a will, with an estate holding a controlling interest in a holding company (Holdco) which owns a portfolio of investments. His Will leaves everything to his adult daughter Jane. Jane wishes to simply have the executor wind up the corporation, pay the wind-up proceeds to the estate and receive her distribution.
Upon death all capital property, including the shares of a private corporation are deemed to have been disposed of for proceeds equal to their fair market value. Any capital gain that arises from this deemed disposition is reported on the testator’s terminal T1 and taxed accordingly. Immediately following death, the deceased’s estate is considered to have acquired the shares at that fair market value, (FMV), and that FMV becomes the shares’ adjusted cost base, (ACB). Using our example of John, if the adjusted cost base of his corporate shares at death is $1, and the FMV is $100, then we have a $99 capital gain (CG). Currently, 50% of CG are included in taxable income, so $99 is taxable at a personal tax rate on taxable gains of 26.76% (50% of the 53.52% top tax rate). The tax on John’s terminal T1 would be about $26.49 and his estate would now have an adjusted cost base in his shares of $100.1
Jane has advised the executor she wants the corporation wound up, so the executor decides to liquidate the investments within the holding company, and thereafter, a wind- up dividend is paid to the estate which is taxed at the dividend tax rate. Assuming the corporation has no tax credits or notional tax accounts (refundable dividend tax on hand or capital dividend account for example) and the ordinary dividend tax rate is 47.74%, the estate has now paid tax on that $100 of 74.5%! (Capital gains tax of 26.76% and dividend tax of 47.74%). So how do we mitigate this tax exposure?
The executor incorporates a new company (Newco) with a nominal ($1) share value and purchases the shares. Next, the executor sells the Holdco shares to Newco from the estate, taking back a promissory note equal to the FMV of the Holdco shares. The Holdco and Newco must remain in place for a minimum of one year due to CRA rules. At the end of that year, Holdco and Newco are amalgamated, and the investments in what was the Holdco are liquidated – giving the corporation the funds needed to repay the debt owing by the corporation to the estate. The only taxes paid on death are those that arise on the capital gains from the deemed disposition of the Holdco shares at death. Jane would end up with about $70, before the expense of implementing this strategy if she was to decide to proceed with the pipeline strategy. As mentioned above, a tax professional’s advice should be sought as this is a very simplistic review of a complex tax strategy.
The capital loss carryback strategy, when implemented correctly only results in the taxation of a dividend, the pipeline strategy on the other hand, only results in the taxation of the deemed capital gain that arises on death. Remember when I noted the significant difference between the dividend and capital gains tax rates? This is the strategy for the tax savvy only.
Pipeline Planning is a more complicated strategy to employ when comparing it to the loss carryback strategy. It will take more time to realize a tax savings and it is more costly to implement. It is also a strategy that the CRA has called into question more than once. One must also consider the cash needs of the beneficiaries before implementing this strategy as the beneficiaries have to be willing to wait for their inheritance.
Consider the executor as the director of an orchestra of considerations, most important of which is to facilitate the most efficient and cost-effective distribution of the deceased’s assets. A professional executor will not only take care of the more mundane and time-consuming tasks of estate administration, but also add value to the estate by employing sophisticated strategies to reduce its biggest expense, income tax.
 Income Tax Act s.84(2)